Cryptocurrency and FTX, 6 months on
Never a stranger to volatility, cryptocurrency has seen a number of ups and downs over the years since its inception back in 2009. The last year, however, has been a particularly eventful one.
May 2023 marked six months following the collapse of the crypto exchange FTX. This proved to be a watershed moment for the industry and which has had substantial implications for both crypto firms and consumers, and has resulted in increased in scrutiny from governments and regulators.
We have set out below a recap of what happened to FTX, why this occurrence was so significant and what has happened in the crypto world in the six months since.
2022 – A recap
In the early months of 2022, there was plenty to be positive about in the crypto world, particularly within the UK. April 2022 saw the end of the Financial Conduct Authority’s Temporary Registration Regime, and the full implementation of the legal requirement for all new and existing cryptoasset businesses to register with the FCA for the purposes of anti-money laundering rules before being able to operate. This concluded a two-year implementation process, and was one of the first key steps towards introducing a regulatory framework for crypto, and helped drive efforts to move it away from its perception as a tool for crime and money laundering.
A more significant political development also came in April 2022 with the announcement of the UK government’s plans to make the country a “global hub for cryptoasset technology and investment.” These plans were spearheaded by then-Chancellor Rishi Sunak, and comprised an initial package of plans including the planned use of stablecoins as a recognised form of payment, and opened up a call for evidence regarding the use of distributed ledger technology in financial markets. The announcement also included plans for the government to work with the Royal Mail to create its very own non-fungible tokens (NFTs). Sunak’s subsequent elevation to the role of Prime Minister later in the year only served to bolster confidence in these pledges.
In terms of the markets, summer 2022 saw ongoing fluctuations in the value of Bitcoin – itself the largest and arguably the most well-known cryptocurrency – which were indicative of gradual market re-balancing following volatility which had been seen over the year prior.
On the tech front, progress was made in September 2022 when the Ethereum network successfully migrated its operating systems from a ‘proof of work’ system to ‘proof of stake’. This was expected to significantly cut down the amount of work and energy required to enable the network to operate and for transaction validations to occur, which has long been a source of criticism for cryptocurrencies.
Despite this buzz of activity, crypto had its “Black Friday” moment in November 2022, with the much-publicised collapse of FTX, which looked to undo much of the positivity that had been generated over the course of the year.
What was FTX?
FTX (short for “Futures Exchange”) was a Bahamas-based company led by CEO Sam Bankman-Fried, which operated as an exchange for cryptocurrencies and other digital assets.
Crypto exchanges are intended to allow users and investors to store their digital assets online, and allows users to swap, buy, sell, and exchange cryptocurrencies. In practical terms, crypto exchanges operate in a similar way to a traditional exchange platform and can also resemble a type of banking service, and there are a number of potential benefits to customers in using an exchange. They can allow users easy access without the need for self-storage and the risk of the user losing their own wallets or the “keys” necessary to access these. They also facilitate and enable the purchase and sale of crypto assets, and so can be particularly attractive to investors who are often looking to buy and sell quickly.
Like a bank, however, crypto exchanges are also businesses in their own right and aim to make profits from the services they provide. Crypto exchanges are also susceptible to market pressures and liquidity shortages. In the case of FTX, market speculation arose following a mass-sale of the cryptocurrency FTT (FTX’s own native token), resulting in a classic bank run situation, with customers seeking to withdraw their cryptoassets from the exchange. FTX proved unable to fulfil the volume of customer withdrawal demands, and it quickly ceased processing withdrawals altogether. Shortly afterwards, Bankman-Fried resigned his position and administrators took control of the company’s affairs and conducted an initial investigation into the state of business. The subsequent Bankruptcy filings made for sobering reading. These indicated that the total assets held could not be readily identified by the administrators, though were believed to be worth billions. As for the operation of the business itself, the administrator’s findings were stark:
“Many of the companies in the FTX Group, especially those organized in Antigua and the Bahamas, did not have appropriate corporate governance. I understand that many entities, for example, never had board meetings…”
“The FTX Group did not maintain centralized control of its cash. Cash management procedural failures included the absence of an accurate list of bank accounts and account signatories, as well as insufficient attention to the creditworthiness of banking partners around the world.”
“In the Bahamas, I understand that corporate funds of the FTX Group were used to purchase homes and other personal items for employees and advisors…”
“The Debtors did not have the type of disbursement controls that I believe are appropriate for a business enterprise. For example, employees of the FTX Group submitted payment requests through an on-line ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis…”
Almost overnight, FTX went from being the third largest crypto exchange globally to being all but wiped out. Millions of customers were left unable to access their funds, with no indication as to when – if at all – they could expect to recover their funds. On the back of this, Bankman-Fried was arrested and charged in the US for various counts of fraud and other activities, with a trial expected to take place in late 2023.
The impact of FTX
It is hard to understate the significance of the FTX collapse on the cryptocurrency industry. Some may ask how the failure of a single business can have such a significant impact on an industry in the way FTX has.
The answer to this perhaps lies in the fact that cryptocurrency remains a relatively new and emerging technology, with public knowledge and understanding being relatively limited, meaning that overall confidence and trust in the technology is not yet established. Furthermore, whilst there are a significant number of cryptocurrencies and business operating within the industry, public knowledge is typically limited to just a small number of these entities, which gives those particular businesses and assets a large amount of power within the industry. So, when one of these key market players fail, this alone can be significant in shaping opinions. Cryptocurrency also has an ongoing battle in fighting against a reputation as being a tool mainly used for illegal purposes, and so the initial findings published about the management of FTX inevitably adds fuel to this fire.
It is important to note at this stage that cryptocurrency and cryptocurrency exchanges are not one and the same – an exchange is an institution designed to enable the storage and exchange of cryptocurrencies such as Bitcoin. It is not of itself an asset, although may issue its own forms of currency and digital tokens. In practical terms, however, the two are often grouped together within a wider concept of ‘crypto’, and so the failure of an exchange may often be perceived as an indictment of cryptocurrencies themselves.
In the immediate aftermath of the FTX collapse, other crypto exchanges began damage-control exercises to try and reassure their customers and re-establish market confidence. Some exchanges went to the extent of publishing their own accounts and proof of reserves, in order to convince customers that their assets were safe.
The fallout from FTX unsurprisingly caught the eye of governments and regulators. Less than two weeks following the collapse, the Deputy Governor for Financial Stability at the Bank of England, Sir Jon Cunliffe, publicly spoke about FTX and the problems with cryptocurrencies as he saw them:
“‘Crypto’ was born in unregulated space: indeed, part of the objectives of its early developers was to create a financial system outside regulation. While not yet of systemic scale, the crypto ecosystem has grown very rapidly in recent years and broadened to encompass a range of financial services.
Moreover, it is not clear to what extent to which these platforms are truly decentralised. Behind these protocols typically sit firms and stakeholders who derive revenue from their operations. Moreover it is often unclear who, in practice, controls the governance of the protocols.
More generally, as with driverless cars, they are only as good as the rules, programmes and sensors which organise their operations.”
Critically, he also indicated that whilst the failure of a crypto exchange such as FTX was not presently enough to threaten wider financial markets, he did not wish to see a situation where such a scenario could happen, and so expressed support for an effective and robust regulatory framework for crypto.
As the year drew to a close, it seemed that fortunes had taken a significant downturn for cryptocurrency. The positivity surrounding the industry from earlier in the year and the UK’s plan to build a “global hub” was in significant doubt.
As the dust has begun to settle following the events of FTX, 2023 has seen a number of developments take place which suggest crypto is on a gradual – if unsteady – road to recovery.
At the start of February, the UK Government released the details of its plans to formally regulate cryptocurrency and digital assets, declaring “we remain steadfast in our commitment to grow the economy and enable technological change and innovation – and this includes cryptoasset technology.”
As part of the announcement, the government opened up a public consultation and call for evidence in respect of its plans, which include proposals to categorise the acts of arranging and advising on crypto investments as regulated activities for the purposes of the Financial Services and Markets Act (Regulated Activities) Order 2001, as well as bringing the marketing of cryptoassets and associated investments into the remit of the existing regulations on financial promotions.
The re-pledging of commitment towards cryptoassets was a welcome move for the industry, which had been left in a state of uncertainty following the FTX collapse and the criticisms raised by regulators in the aftermath.
As the public consultation for crypto regulation began, the FCA remained diligent in monitoring potentially illegal crypto activity, and issued details of recent crackdown operations it had overseen across the country in conjunction with the Metropolitan Police in respect of “Crypto ATMs”, which are machines allowing people to acquire crypto assets by depositing cash. The FCA has issued reminders that, at the time of writing, no businesses were registered or authorised to operate such machines.
This same month saw another significant development which may have inadvertently served to bolster crypto’s fortunes. This was the collapse of the US-based Silicon Valley Bank (“SVB”). This was a bank which had typically focused on the technology sector, but which faced growing market uncertainty owing to various concerns about its investment strategy and liquidity, which culminated in another ‘bank run’ situation with customers seeking to withdraw their funds en masse, which the bank struggled to fulfil. UK customers were luckily safeguarded following action by the FCA which oversaw and approved the purchase of the bank’s UK arm by HSBC. This prevented the need for any government bailouts, and helped to ensure UK customers were able to go about business as normal.
Nonetheless, the situation with SVB often looked to be comparable to what had been seen with FTX mere months earlier. This served as a reminder that even traditional financial institutions such as banks are not immune to financial pressures and can ultimately fail, resulting in potentially significant impacts on consumers. It showed that the issues which were seen with FTX were perhaps not down to any inherent risks or failures of cryptocurrency itself.
On 17 May, the UK’s Treasury Committee released a report setting outs its analysis of the crypto-asset industry and its views as to how future regulation should work. Whilst the Committee welcomed the government’s proposals from earlier in the year for regulating the industry, it also made it clear that it considered unbacked cryptoassets such as Bitcoin to have no intrinsic value and serve “no useful social purpose”. It further expressed concerns that if the government regulated cryptoassets as a form of financial service, this risked giving consumers a false sense of security about the assets and could lead them to believe investments are safer than they are.
The Committee summarised its findings by saying it must “strongly recommend that the Government regulates retail trading and investment activity in unbacked cryptoassets as gambling rather than as a financial service.”
In response, the trade association, CryptoUK, published a statement saying that it “strongly disagreed” with the Committee’s findings and considered them “unhelpful, false, fundamentally flawed and unsubstantiated” as a whole, and that it failed to “reflect the true nature, purpose and potential of the crypto industry”. It did, however, confirm its willingness to work with and support the government’s moves towards regulation and to engage with the FCA and Treasury to work to find solutions to some of the problems presented. These statements perhaps signify a potential for greater collaboration and communication between the industry and regulators in the future.
At the start of June, the UK’s All-Party Parliamentary Group for Crypto and Digital Assets issued its initial report following its inquiry into the topic of crypto regulation, which contained details of the submissions it had heard during the course of its investigations, along with making a series of recommendations for policymakers. In a stark contrast to the Treasury Committee’s report from the previous month, this latest report talked about the practical benefits of crypto and made particular reference to how cryptocurrencies had been used by Ukranians to allow them to continue to buy goods and services even after infrastructures and ATMs were damaged due to the ongoing conflict. The report went on to talk about how the Government should aim to “harness the significant opportunities” for economic growth arising from crypto, and emphasised the need to ensure regulators were given sufficient resources and skills to be able to properly understand the industry and to effectively regulate it.
As the events of the past year have shown, cryptocurrency remains incredibly unpredictable and it is in often hard to predict from one month to the next what developments will be seen.
2022 was, in many respects, a positive year for the industry, particularly within the UK, thanks to the government’s declarations of its ambitions for the use of digital assets. Whilst, it cannot be denied that the failure of FTX also caused the industry and its reputation to suffer significant damage, it does seem that this was also one of the key moments which served to spur governments and regulators to really move forward with their plans for regulation and the introduction of a proper legal framework for the industry, which can only prove beneficial in the long run and help the industry move it away from its “Wild West” image.
Overall, from the events of 2023 it does appear that crypto is on a gradual road to recovery following the events of FTX, and the UK in particular is clearly driving towards bringing about a full and robust regulatory framework for these assets. Whilst there will inevitably be further challenges on the way, the moves towards a proper regulatory framework may go a significant way to showing that crypto is here to stay and that the industry can learn the lessons it needs to from FTX, and allow cryptocurrency to continue to innovate and challenge financial norms in a way which will support individuals and investors alike.
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